Search interesting materials

Monday, October 23, 2006

An impending cartel of airlines?

I wrote an article in Business Standard about the issues on competition policy and airlines, titled Revel in competition. Here, I worry about the impending cartel, and argue that the hallmark of a well functioning market economy is `creative destruction', where firms continually die and firms are continually born.

This falls in the context of a flurry of bad news for ailines in recent weeks. Is it bad to have an episode where an industry experiences a drop in profit? On 25 September, Business Standard had an editorial on the subject:

With the pioneer among low-cost carriers (LCC) wiping out half its net worth in a short 15 months, it is time to take a long hard look at an aviation sector that seems to have got caught in very rough weather. For, the country's largest (full-service) airline's chairman told his shareholders last week that, while Indian carriers had been expected to lose Rs 2,200 crore during the year, this figure would climb as more low-cost carriers entered the market. Since Naresh Goyal is presumably including in his numbers those of Air-India and the foreign operations of Indian Airlines, this translates to loss levels equalling 10-12 per cent of turnover. Any business with those numbers is going to have a short life.

In the weeks prior to announcing his disastrous results, Deccan Air's Captain GR Gopinath was citing the example of telecom to calm nervous investors: Airtel made huge losses in the initial years, he said, while building up a client base, and this was just part of doing business. Mr Gopinath is absolutely right, and he has been adding one new aircraft every month since he first opened his doors to passengers?and also deviating from the LCC model of sticking to just one kind of aircraft (which may partly explain his current troubles). In any case, there is one aspect he did not speak of: just three or four of the original band of 10-11 players in the telecom business are around today. Will there be similar consolidation in the aviation business?

It certainly seems that there is no hope of the sector making profits if fare discounting does not stop - and for that there has to be consolidation in the market so that the fight for market share is not ruinous, as indeed it has been in the US, where too every airline is now bankrupt. The alternative, as the civil aviation minister has threatened, is regulation: which might be considered the European model. The problem with that is it would preclude the rapid growth of the business that has been in evidence over the past year, recording an astonishing 40 per cent and more and taking aviation beyond the segment of business travellers to include those travelling at their own expense, having upgraded from rail.

Some analysts still believe in the LCC model, as opposed to the full-service model of Jet and Indian Airlines. But at today's prices, each extra mile flown is adding to losses. Just the fuel costs to fly a mid-sized jet from Delhi to Mumbai is around Rs 3.5 lakh: so, a low-cost carrier needs around 90 passengers to cover just this, and fuel costs are just 40 per cent of total costs. So, even a plane with 130-140 passengers on board is losing money when it takes off. So unless there's consolidation (as Jet tried by merging with Sahara before the deal fell apart) and fares go up, it's difficult to see how low-cost carriers can justify their existence at today's below-cost prices. If the losses that Mr Goyal warns of were to materialise, investors will need to take a call on whether they want to fund them. It is equally clear from the aborted Jet-Sahara deal that the chances of investors exiting at a reasonable price aren't great.

Civil aviation minister Praful Patel has convened a meeting of all airline chiefs amidst growing concern over huge losses -- estimated to be around Rs 2,200 crore for the current year -- incurred by the industry. The government now fears that the aviation boom -- where growth has ranged between 30% to 50% since early '06 -- may soon go bust due to overcapacity and mindless competition.

It is understood that the government may intervene and put on hold fresh approvals for airline companies till the proposed civil aviation policy is formulated. Established airlines may be asked to consider voluntary calibration of capacity addition to avoid overcapacity. This may mean a temporary go-slow on capacity addition for the airline sector. For consumers, however, this is not good news since slowing down capacity additions may force cheap fares to disappear from the market. Some airlines feel growth should not be at the cost of bottomline as this would force carriers to collapse like a pack of cards.

Mr Patel would discuss key issues with airline chiefs on Thursday evening, highly-placed official sources said. It is understood that head honchos of all airlines, including Jet Airways, Indian, Air-India, Air Deccan, Kingfisher, SpiceJet, GoAir, IndiGo and Paramount have been invited for the consultation.

The ministry does not want a repeat of the post-1991 boom & bust cycle in which a number of players, including East West, Damania and ModiLuft, went down under. While capacity grew rapidly and passengers benefited due to better services, the financials of these airlines could not simply hold on. The ministry wants the current boom to sustain and not turn into a bubble. "We have seen growth of up to 50% in some months but airlines are bleeding," an official said.

All major players, including Jet Airways, Air Deccan and SpiceJet which are listed companies, are in the red while Kingfisher and GoAir have not turned out any profits so far. Since most players in the industry are planning large expansion which could lead to further bleeding. The failed Jet-Sahara deal, valued at Rs 2,300 crore, has also led to concerns about the need for a better business climate.

Air Deccan recently announced a Rs 340-crore loss for the 15-month period ending June '06. SpiceJet, another rapidly-expanding carrier, lost Rs 41 crore in '05-06. Even market leader Jet Airways is suffering losses and its chairman Naresh Goyal expressed the fear that the industry would lose Rs 2,200 crore this year. The Centre for Asia Pacific Aviation (CAPA) has also predicted huge losses for airlines till next year. "The situation has to be considered with concern. Almost all airlines are making losses," said Ajay Singh, director, SpiceJet. The estimated losses for the industry works out to a worrisome Rs 6 crore per day.

Since new players like Kingfisher and GoAir are closely-held companies, it is not known how much they have lost during the current boom. Air-India, which is still in the black, recently announced that its net profit for '05-06 was only Rs 16.3 crore as compared to Rs 93.3 crore the previous year. The 83% decline in profits are due to increasing input costs, primarily hike in fuel prices and human resource. The other state-run carrier, Indian, is also said to be facing severe pressure due to high fuel prices and intense competition.

The top brass of all of the country's airlines will meet in Mumbai on Monday to thrash out the broad contours of a common industry-wide turnaround strategy. Aviation analysts, however, expected that the meeting might see a division within the industry on the contentious issue of a price war unleashed by the new low-cost airlines (LCCs).

"The concept of a restriction on further cut in tariffs is not going to be acceptable to us as we work on the very model of low fares," Spicejet CEO Siddhanta Sharma told /Hindustan Times/.

There are expectations that full service airlines such as Jet Airways, Sahara and Indian (IA) might pitch for a partial restriction on predatory fare cuts. Globally, there is no evidence of airlines getting together to decide on matters of fare and tariffs.

The meeting is also expected to take up the issue of capacity addition, which is cited by many as the primary reason for the bleeding balance sheets of airlines, as they try to boost market share and brand value to maintain volumes that help long-term viability.

"Everybody is adding capacity in a market that is showing low yields. There has to be some rationality in capacity," said Sharma.

The chief executive officer (CEO) of a budget airline, who did not wish to be identified, said that the idea behind AI convening the meeting is to ensure neutrality as it does not operate on domestic routes.

The invitation sent out by Thulasidas to all airline CEOs says that the meeting will address "a collaborative growth agenda for the airline industry in India."

The government has also expressed concern about the financial health of the domestic civil aviation industry . At a recent meeting with airline CEOs, Civil Aviation Minister Praful Patel indicated that the government would explore appropriate policy interventions to bring down the operational costs of airlines.

The meeting on Monday is also expected to take up the idea of "cash-flow pre-audit" of airlines, where the airlines submit an anticipated cash-flow of the ensuing three months.

The industry is not averse to the idea of submitting a quarterly business plan on a prospective basis. "No airline present in the meeting with the minister recently has objected to the proposal. It is in a way good for us as it gives us an opportunity to plan ahead", said Sharma.

The airline industry is not alone. We have plenty of problems on competition policy in other areas also. As an example, look at recent evidence on competition policy problems in banking, as seen in a story on 25 September 2006 in Business Standard titled RBI nod delay hits Vijaya expansion:

Vijaya Bank sees itself falling short of its target with regard to branch expansion. The bank had earlier targeted taking its total number of branches to 1,000 from 925 at present. Meanwhile, it may also declare interim dividend after half-yearly results this year.

Prakash P Mallya, chairman and managing director, told mediapersons, "We already have placed applications for 143 branches with the Reserve Bank of India (RBI). We had targeted crossing the 1,000-mark by the end of March 2007. But the approvals are pending with the RBI and as I see it, crossing the 1,000-mark may not be possible this year. However, we may cross the 950-mark by then." Mallya said the bank had also applied for branch licences in Hong Kong, China and Dubai.

...

As a consequence, we have this strange phenomenon of buyers queuing up to buy a bankrupt bank, so as to be able to grab it's licences. As Business Standard wrote in an edit on 12 September, titled Attractions of bankruptcy:

Over a dozen entities have lined up to take over the troubled United Western Bank. For the small, 70-year-old, Satara-based private sector bank, which has eaten up its capital, this is an extraordinary swayamvar. Commercial banks of all hues, non-banking finance companies, a co-operative bank, a stock broker and even a state government have thrown their hats in the ring. The list of suitors includes Canara Bank, Corporation Bank, Andhra Bank, Allahabad Bank, Uco Bank, Bank of Maharashtra and IDBI from the public sector; Federal Bank and ICICI Bank from the private sector; Standard Chartered and Citi among foreign banks; Indiabulls Financial Services; stock broker Pradeep Bhavnani; Saraswat Co-operative Bank and, last but not the least, the Maharashtra-HDFC-IDFC-Sicom combine. With so many takers eagerly waiting for the regulator's nod, the United Western stock which had plunged from Rs 22.60 on September 1, a day before the Reserve Bank of India (RBI) imposed the moratorium on the bank, to Rs 16.14 on September 4, bounced back to Rs 21 by September 8. Each new suitor has sent the stock price up by another notch.

The bank had reported a net loss of Rs 98.64 crore in 2004-05, and followed it up with another Rs 106.48 crore net loss in 2005-06. For the quarter ended June, its net loss was Rs 6.08 crore. Although United Western showed a capital adequacy ratio of 0.67 per cent last year, going by the RBI's internal estimate, it could now be minus 0.3 per cent. On July 31, the gross non-performing assets of the bank were 13.84 per cent (Rs 493 crore) and net NPAs 6.16 per cent (Rs 201 crore). This is against the peer group's average net NPA of 1.97 per cent.

What explains this rush to lap up a poor specimen of the banking industry? Indiabulls, a rapidly growing financial services company, wants to convert itself into a banking entity by merging United Western Bank with itself. It has valued the bank at Rs 300 crore. The Maharashtra government, on the other hand, is keen to retain the bank's Marathi ethos. It is willing to pump in Rs 210 crore to help the bank retain its regional identity and prevent a merger with bigger banks. For most of the serious bidders, the major attraction is the bank's branch network. It has 230 branches, 12 extension counters and 75 ATMs. The bulk of these branches are in the cash-rich belt of Mumbai-Thane-western Maharashtra. The location of the branches will help the prospective acquirer expand its agricultural portfolio and achieve priority sector lending targets by focusing on agriculture and small-scale industries.

Considering that fresh capital infusion of at least Rs 350 crore is required to revive the bank, the suitors are willing to spend close to Rs 1.5 crore for every single branch. Prima facie, this is too high a price as opening a new branch in semi-urban and rural pockets costs much less. So, if there is a scramble to take over the bank, it is because of the RBI's restrictive branch licensing policy. The banking regulator is never liberal in allowing foreign banks to expand their branches. Local players too are encouraged to focus on under-banked districts. The scarcity of branch licences has further been intensified with the regulator unwilling to allow some of the fast-growing banks that were involved in the demat scam to expand their branch network. For them as well as for the foreign banks, acquisition is the only route to grow their branch network, even if it means acquiring a bankrupt bank. That would suggest a problem with the branch licensing policy.

I guess the greatest fantasy of every airline CEO is that when he chooses to throw in the towel, a stream of prospective buyers will step forward to buy the failed airline for the value of the licence.

We get over 18,000 visitors per day.Many are looking for business lead listrelated products and services.

We have a specific category for business lead list .Your listing will be spidered by the searchengines under business lead list . Our pagesare made to be search engine friendly.We hope you take a moment to takeadvantage of this free advertising.

Please note: Comments are moderated. Only civilised conversation is permitted on this blog. Criticism is perfectly okay; uncivilised language is not. We delete any comment which is spam, has personal attacks against anyone, or uses foul language. We delete any comment which does not contribute to the intellectual discussion about the blog article in question.

LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.